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CHAPTER 4
EXTENSIONS AND TESTS OF THE CLASSICAL MODEL OF TRADE
Learning Objectives:
■ Explain how money and prices affect the Classical model.
■ Demonstrate how wages and exchange rates conceptually alter comparative advantage
and international trade patterns.
■ Examine the implications of extending the basic model of comparative advantage to more
than two commodities.
I. Outline
Introduction
– Trade Complexities in the Real World
The Classical Model in Money Terms
Wage Rate Limits and Exchange Rate Limits
Multiple Commodities
II. Special Chapter Features
Concept Box 1: Wage Rate Limits and Exchange Rate Limits in the Monetized
Ricardian Framework
In the Real World: The Size of Transportation Costs
III. Purpose of Chapter
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IV. Teaching Tips
A. This chapter begins with a look at the real-world complexities of trade that are omitted
from the previous chapter’s discussion. This should help the students to understand the need to
examine the extensions of this chapter.
B. The key to using this chapter is to make certain that the student can work with and
understand the Classical model in money terms. This provides a framework for demonstrating
not only additional microeconomic aspects of international trade but also the important role of
the exchange rate. The monetized model incorporating the exchange rate makes the international
terms of trade explicit and does not just indicate the limits to the terms of trade.
V. Answers to End-of-Chapter Questions and Problems
1. As a result of the trade surplus, France experiences, under a fixed exchange rate, a net
gold inflow and the United Kingdom experiences a net gold outflow. Assuming that the price-
specie-flow mechanism is in operation, these gold movements will result in an increase in prices
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2. (a) There is a basis for trade here because the relative labor costs for the two
commodities are different in autarky, i.e., 6/8 is not the same as 4/4. From another
perspective, the individual price ratios in autarky are different between the two countries,
i.e., they are 1 wine:0.67 shoes (or 1S:1.5W) in Italy and 1 wine:0.5 shoes (or 1S:2W) in
3. Given the Swiss wage rate of 3.5 francs per hour and the 1:1 exchange rate, the limits to
the wage in Italy are 4⅔ and 3½ euros/hr.
4. Italy will export shoes and import clothing, wine, cutlery, and fish. Switzerland will
export clothing, wine, cutlery, and fish and import shoes.
With the inclusion of transportation costs, clothing, wine, and fish become nontraded
5. There is a basis for trade for all three countries since all three autarky price ratios are
6. Yes. Since productivity in U.S. manufacturing is considerably higher than in Mexican
manufacturing, one would expect the level of wages to be considerably higher in the United
.
States than in Mexico. For traded goods, if U.S. productivity is five times as high but U.S.
7. (a) The relative wage ratio is (WU.S./WU.K.) = [$20/(£8$2/£1)] = 5/4. Thus the United
Kingdom exports bread and books; the United States exports VCRs, rugs, and lamps.
8. (a) The new U.K. labor times are: bread – 1.6 days; VCRs – 6.4 days; lamps – 3.2 days;
rugs – 2.4 days; books – 1.6 days. With these numbers and the original wage ratio of 5/4,
9. This is to some extent an opinion question, but deficiencies of the Classical model that
could be indicated clearly include the use of the labor theory of value, the constant cost
assumption, and the assumption of a smooth monetary adjustment mechanism. The labor theory
.
10. Increases in foreign country productivity will cause the A = a2/a1 curve to shift downward
as a2/a1 falls for each good. This will lead to a fall in home country export goods (an increase in
VI. Sample Exam Questions
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1. In the monetized Classical model, if trade is not balanced, the international terms of trade
will deteriorate for the country with the trade deficit. Explain why this is so.
2. In the basic Classical model, only the limits to the international terms of trade can be
3. In a two-country Classical model of trade with many commodities, briefly explain what
would happen to the structure of trade in each of the following cases:
4. In a five country-two commodity Classical model of trade, where the autarky price ratios
in all five countries are different, can you conclude a priori that all five countries will desire to
trade? Why or why not? Between which of the five countries is trade certain? What will
determine which of the remaining countries will trade?
5. It is common to read statements to the effect that domestic inflation or production cost
increases hinder our ability to export and also stimulate imports. Is this consistent with the
Classical view of international trade? What effects would such an event have on the overall
economy according to Classical thinking?
6. (a) Set up a Ricardo-type comparative advantage numerical example with two countries
and two goods. Distinguish “absolute advantage” from “comparative advantage” in the
context of your example. Then explain how trade between the two countries benefits
.
7. In the context of the Classical (Ricardo) model, explain, for each of the following two
statements, why the statement is either TRUE or FALSE.
(a) “If country A can produce all goods with less labor time per unit of
8. Set up a Ricardo-type comparative advantage numerical example with two countries and
two goods. Explain how trade between the two countries can benefit each of them in comparison
(Question 9 pertains to appendix material.)
9. (a) Explain the Dornbusch-Fischer-Samuelson (DFS) model of Classical-type trade
between two countries in a very large number of goods. Be sure to describe why each
curve slopes as it does, and indicate the trading pattern at the equilibrium position.